Cheap credit bought only illusion of prosperity

In 2003, after an absence of nearly 23 years, I made a return trip to Ireland. The first time I visited the Emerald Isle, the thatched roofs dotting the rolling countryside were a quaint symbol of its status as one of the poorest countries in Europe. Ireland's per-capita gross domestic product in 1980 was $6,200-roughly half that of Germany and France.

More than two decades later, I found a country wholly transformed. Dublin was a bustling, affluent city, and in rural Ireland sprawling modern homes had replaced the rustic farmhouses. Ireland's days as an economic laggard also were long gone; its per-capita GDP had soared to more than $39,500. Astonishingly, the Irish had jumped ahead of the Germans, the French-even us.

With its roaring growth, Ireland had become known as the "Celtic Tiger." The boom lasted for five more years, pushing per-capita GDP to nearly $60,000.

Then the bottom fell out.

Over the next two years, Ireland's per-capita output fell almost 24 percent. In 2009, its GDP growth rate was minus 7.6 percent, compared with minus 2.7 percent in the United States and a 2 percent decline worldwide.

It turns out Ireland was a paper tiger. Yet the paper was very real-representing a mountain of IOUs that, once the financial crisis hit, the Irish suddenly had no hope of repaying.

The Irish, writer Michael Lewis notes in his new book, "Boomerang," went from "being abnormally poor to being abnormally rich without pausing to experience normality." From 2003 until its growth came to a crashing halt, the Irish boom was fueled chiefly by an injection of cheap foreign money that drove property values sky-high. "By 2007, Irish banks were lending 40 percent more to property developers alone than they had to the entire Irish population seven years earlier."

By late 2010, the Celtic Tiger was better known as one of the PIIGS-the five debt-ridden eurozone nations: Portugal, Italy, Ireland, Greece and Spain. And it had to go hat in hand to the European Union and International Monetary Fund, seeking a bailout of more than $90 billion.

"Boomerang" is Lewis' follow-up to "The Big Short," one of the best books yet written about the U.S. housing crisis. While his new work suffers a bit by comparison to its predecessor, "Boomerang" is a penetrating-and often grimly hilarious-look at the debt crisis now gripping Europe.

"From 2002," he writes, "there had been something like a false boom in much of the rich, developed world. What appeared to be economic growth was activity fueled by people borrowing money they probably couldn't afford to repay."

The financial crisis of 2008 brought the United States and many other developed countries to the brink economically-and, Lewis warns, they remain dangerously close to the edge. Why? Because in response to the crisis many central banks and national treasuries took on the risk of countless bad loans made by private financiers.

Lewis' travels in "the new Third World" took him to Iceland, where debt reached 850 percent of the nation's GDP; to Greece, where lavish public-sector pay and benefits helped drive total obligations to a level equal to $250,000 for every working Greek; and to Ireland, where "a handful of Irish politicians and bankers had decided to guarantee all the debts of the biggest Irish banks." (The Irish government last week said it should be relieved of some of this "unfair" debt burden.)

Even the sober Germans, who resisted the temptation of cheap credit, were part of the problem, Lewis concludes. "Other countries used foreign money to fuel various forms of insanity," he notes. "The Germans, through their bankers, used their own money to enable foreigners to behave insanely."

Though our country has its own debt and deficit problems-underscored by the fact that one-fifth of all U.S. residential mortgages are underwater and by the congressional supercommittee's abject failure to reduce the long-term budget gap-the threat to us posed by Europe's sovereign debt disaster is more immediate. Another recession across the Atlantic would hit U.S. exporters hard, as would further weakening of the euro; since summer the European currency has fallen roughly 10 percent against the dollar.

But even more worrisome are the deep financial connections linking European countries to one another and to the United States. (For an excellent primer, see the interactive graphic posted on the BBC's website: www.bbc.co.uk/news/business-15748696.) If a country like Italy defaults, it will be very bad news for banks in many other countries.

As Lewis writes, debt "buys you a glimpse of a prosperity you haven't really earned." To greater and lesser extents, much of the developed world went on a borrowing binge that created a facade of affluence. Then the false exterior was stripped away, revealing the dry rot inside. We now face the dual challenges of cleaning up the mess and relearning how to build real, durable wealth.